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November 13, 2004

Consider Long Term Care Insurance

Have you made provisions for long-term care in your financial plan? Many people don't believe they'll ever need this type of care, but it is estimated that individuals age 65 and over face a 43% chance of entering a nursing home. And approximately 21% of those entering a nursing home will remain there for at least five years (Source: Agency for Healthcare Research and Quality, 2004). The average annual cost of a nursing home is $66,153 (Source: SmartMoney, 2004).

If you're trying to decide whether you should obtain long-term-care insurance, consider these factors:

  • How do you feel about public assistance? Medicaid funds a significant portion of nursing home costs, but those benefits are typically only available after exhausting most of your assets. You may not like the idea of relying on public assistance or may not want to exhaust your assets if your spouse is still alive.

  • Can you obtain a policy at a reasonable cost? Individuals in their 50s or early 60s can typically obtain a policy at a reasonable cost. After that, the cost can become prohibitive and most insurers won't insure individuals over age 79.

  • Did members of your family require long-term care? If your parents or other family members needed long-term care, you are more likely to need care.

  • Do you have family members who could care for you? You may not need long-term-care insurance if you can count on other family members for this care. However, before relying on this alternative, consider whether you want to risk having your family provide years of assistance. The physical, emotional, and financial strain of caring for an elderly family member can be enormous.

  • Do you want to ensure an estate for your heirs? The costs of nursing homes are so high that many years of those costs can deplete your estate. Insurance can make sure assets will be left for heirs, even if you need nursing home care.

If you decide to purchase long-term-care insurance, there are a number of features to consider, including requirements for care, services covered, impairments and illnesses covered, renewability provisions, benefit periods, waiting periods, and inflation provisions.

Money and a Happy Marriage

If married couples can't agree on basic money issues, these issues can become a constant source of conflict. To help avoid money conflicts, consider these tips:

  • Discuss your views on a wide range of money issues, paying particular attention to potential sources of conflict. Make sure you understand each other's views about earning, spending, saving, investing, and borrowing. Does one of you like to save money, while the other prefers to spend it? Does one feel comfortable with high debt levels, while the other can't stand the thought of paying interest? Different money issues will be more important at one stage of your marriage than at another. Thus, you may find you have no money disagreements for years, only to be faced with an issue you can't agree on.

  • Set basic monetary goals and develop a written budget. Especially if you are having conflicts over money, it can be helpful to step back and really think about what you are trying to accomplish. Where do you want to be in 10, 20, or 30 years? What are your most important goals in life and how can you accomplish them? The process of defining goals and setting a budget can help resolve differing views about money matters, forcing couples to compromise and make joint decisions about how money will be spent. While that might seem like a painful process, addressing these issues now can help prevent future misunderstandings. It is often easier to discuss spending preferences on a theoretical basis than it is to argue about an actual purchase.

  • Decide on joint or separate bank accounts. Some couples prefer to pool all funds, while others feel uncomfortable losing control of their money. For couples with vastly different spending styles, separate accounts may reduce tension. A joint account can be used for shared expenses, with each spouse contributing a designated amount to the account. Any remaining funds are kept in individual accounts, for each spouse to spend as he/she desires.

  • Develop credit in each spouse's name. Each spouse should have separate credit cards to develop his/her own credit file. This can be especially important if one spouse dies or the couple divorces.

  • Split financial responsibilities. Decide who will handle financial tasks, such as paying bills, preparing tax returns, making investment decisions, etc. One person may be more suited for these tasks due to their background or time availability. However, the other spouse should not give up total control.

  • Discuss financial matters periodically. Set up a formal time, perhaps monthly, to go over financial matters. This keeps both spouses fully informed and provides a designated time to discuss spending or items of concern. You then won't fret about how to bring up financial topics or let finances interfere during other times.

What Will Happen to Real Estate Home Prices?

The one bright spot in the economy the past few years has been the housing market. Despite stock market declines and slowdowns in other areas of the economy, housing sales have been brisk and housing prices have continued to advance. But have housing prices increased too much in the recent past?

In general, housing prices tend to increase in line with personal income, since income determines how much a homeowner has available to spend on housing. From 1980 to 2001, that trend remained intact -- median income rose 138% while housing prices rose 136% (Source: The Wall Street Journal, June 14, 2004).

However, recently, home prices have been increasing faster than income. From 1996 to 2003, income rose 22% while housing prices increased 47% (Source: The Wall Street Journal, June 14, 2004). One of the primary reasons for this divergence is historically low mortgage rates. With much lower mortgage rates, homeowners were able to purchase larger homes and still have a smaller mortgage payment.

Despite the rapid growth in housing prices, several studies indicate that housing may only be overpriced in selected areas, generally on the coasts. For instance, a recent study by economists at Wellesley College and Yale University found that housing prices were in line with income in 42 states. Housing prices in only eight states were higher than personal incomes would warrant (Source: Money, March 2004).

Generally, however, even those who believe housing prices are too high don't believe there will be a housing crash similar to the recent stock market crash, for several reasons. First, the real estate market is not as homogenous as the stock market. Housing prices in one part of the country, even if vastly overpriced, have little to do with housing prices in other parts of the country. Second, most people don't try to time the housing market. Even if housing prices seem high in your area, you're not likely to move across the country for a cheaper house. You need to live close to where you earn a living. Third, while it is possible for housing prices to decline, it is generally felt that it is more likely for housing prices to simply level off for a while until personal incomes rise to match prices.

The concern is that now that the Fed has started raising interest rates, housing will become less attractive as rates rise. Fewer people will be able to afford the mortgage payments, putting pressure on housing prices.

With the future of housing prices looking uncertain, what can you do? Make sure you are living in a home you will be comfortable living in for at least five to 10 years. When housing prices are under pressure, the individuals who are hurt the most are those who must sell, usually due to a job change or because they can't afford their home. As interest rates rise, individuals with adjustable rate mortgages could find their mortgage payments going up dramatically. If you're barely able to make ends meet with the current low interest rates, you might want to lock in a fixed rate to remove that uncertainty.

The Basics of Currency Fluctuations and Currency Exchange

An international investment's total return is based on two factors -- the investment's return in local currency plus currency fluctuations. For example, suppose you purchase a British stock whose price increases 10% in one year in terms of British pounds. If, during that same year, the British pound increases in value by 5% compared to the U.S. dollar, your total return would be 15% -- 10% from the investment's return plus 5% from currency fluctuations. However, if the British pound decreased in value by 5%, your total return would be 5%.

When the U.S. dollar declines compared to the other currency, your investment increases in value since more dollars are then required to purchase the investment. An increase in the U.S. dollar compared to the other currency means your investment decreases in value.

Most countries use a system of managed floating exchange rates. Supply and demand factors set the exchange rates most of the time, as international banks, investors, tourists, consumers, and multinational companies buy and sell foreign currencies and goods. Governments typically only intervene to prevent massive fluctuations in exchange rates.

Demand for a particular currency is determined by many factors, including a country's inflation, interest rates, political and economic outlook, monetary policies, and speculation. The U.S. dollar does not move uniformly against all currencies -- it can be rising against one currency while it is declining against another.

In general, a rising dollar makes it less expensive for Americans to travel abroad, to import foreign goods, and to purchase foreign investments. However, U.S. companies may suffer since cheaper imported goods hurt sales of domestic products. When the dollar is declining, it becomes more expensive for Americans to travel abroad and to import foreign goods, but U.S. goods become more competitive in international markets.

When considering international investments, consider these tips about currency fluctuations:

  • Foreign bonds are subject to more currency risk than foreign equities.

  • Currency fluctuations tend to be more moderate in parts of the world where political and economic factors are stable and the local currency is strong. Avoid areas where inflation rates are extremely high.

  • Diversifying your investments by country and region can help reduce the overall effects of currency risk.

Are Stock Market Correlations Increasing?

A primary reason to invest in international stocks is to diversify your portfolio to reduce its risk. If world markets do not move in perfect harmony, owning stocks from different countries should reduce the impact of a downturn in one stock market. But as investing becomes more global in nature, there is concern that stock markets are becoming more correlated.

What Is Correlation?

Correlation is a statistical measure of the extent to which one asset class moves in relation to another asset class. Correlations can range from +1 to -1. A correlation of +1 means the two assets move very closely together in the same direction. A correlation of -1 indicates the assets move in opposite directions, a rare event in the investment world. A correlation close to 0 means no relationship exists in the price movements of the two assets. Combining assets that aren't highly correlated can help reduce volatility.

Correlations of International Markets

Almost all stock markets in the world are correlated to some degree, so correlations between stock markets will generally be positive. However, the closer that number is to 0, the less one market is impacted by the other. In general, European stock markets are more closely correlated to each other and the U.S. than to markets in Japan or Asia. Correlations between developed countries tend to be higher than correlations between developed and emerging countries.

But are stock market correlations around the world increasing? Major negative political or economic events, such as the oil embargo crisis, the U.S. stock market crash in 1987, the Gulf War in the 1990s, and the U.S. technology stock market decline, had repercussions in stock markets throughout the world. Recent research found that stock markets are more closely correlated during periods of recession than during periods of expansion. During U.S. recessions, the correlation between the U.S. stock market and the German stock market was 0.64, 0.69 for the United Kingdom stock market, and 0.60 for the Japanese stock market. During U.S. expansions, those correlations decreased to 0.51 for the German stock market, 0.55 for the United Kingdom stock market, and 0.34 for the Japanese stock market (Source: International Monetary Fund, September 2003).

Correlations can change significantly from year to year. For instance, in 1995 the correlation between the U.S. stock market and foreign stock markets went as low as 0.20, climbed to 0.6 by 1998, declined to 0.4 by 2000, spiked to 0.75 by 2002, and retreated some to 0.6 by 2003 (Source: International Monetary Fund, September 2003). Overall, between 1980 and 2003, the correlation between the Standard & Poor's 500 (S&P 500) and foreign stocks was 0.7 (Source: Fortune & Misfortune, June 2004). This correlation is low enough for a diversified portfolio of international stocks to help reduce risk in a portfolio. Correlations change over time though, so these trends should be monitored.

Other Considerations

There are other reasons to consider international investing:

  • Investment opportunities -- The U.S. stock market now represents about half of the total value of global stocks, down from two-thirds in 1970. Of the 10 largest companies in the steel, electronics, and appliances industries, none are based in the U.S. (Source: The Washington Post, June 27, 2004). Limiting yourself to U.S. stock investments means eliminating half of the world's investments from consideration.

  • Return potential -- During the 1990s, the U.S. stock market clearly outperformed international stocks. But that has not always been the case -- international markets outperformed U.S. stocks during the 1980s. For 2002 and 2003, cumulative returns for the S&P 500 were 0.2%, while foreign stocks returned 16.5% (Source: Fortune & Misfortune, April 2004).* While no one knows whether this trend will continue in the future, there may now be opportunities to find investments in other parts of the world that are more attractively priced than those in the U.S.

  • Currency fluctuations -- Your return from an international investment is comprised of two components -- the investment's return in local dollars and the impact of any currency fluctuations. Currency fluctuations significantly impact total returns from foreign investments. Part of the reason U.S. investments dominated in the 1990s is due to the strong U.S. dollar. Recently, the U.S. dollar has weakened against many other currencies, helping to bolster returns of foreign investments.

Before investing in international stocks, assess how much of your portfolio to allocate to this asset class. This will depend on personal factors, such as your risk tolerance, time horizon for investing, and comfort level with foreign investing. Keep in mind that international investing may not be suitable for everyone. In addition to the risks associated with domestic investing, international investing has unique risks, including currency fluctuations, political and social changes, and greater share price volatility.

* The S&P 500 is an unmanaged weighted index generally considered representative of the U.S. stock market. The MSCI EAFE Index is an unmanaged index of 1,000 foreign stocks generally considered representative of stock markets outside the U.S. Past performance is not a guarantee of future results. This information is presented for illustrative purposes only. Investors cannot directly purchase an index.

 

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